A look into the risks of UST, Luna, Anchor and Mirror.
While it is easy to ape into protocols on Terra, it’s worth taking the time to understand the risks associated with them. Knowing what situations can cause the protocol to fail will help you better understand how they work and subsequently rebut FUDs.
In this article, I’ll cover the risks associated with UST, Luna, Anchor and Mirror using crypto analytics tools from Flipside.
Have you stopped to ask yourself how Luna gets its value?
In my opinion, Luna derives value from the wide adoption of UST. As more UST is used in Terra and out of Terra, more UST has to be minted. Swapping Luna for UST in Terra station burns Luna. As more UST is minted, more Luna is burned which reduces supply of Luna. When supply decreases, Luna should be more valuable.
So if you hold Luna, you believe that UST will be used and adopted widely. I think Terraform Labs bootstrapped this adoption really well by building 2 protocols early on serving the basic needs of saving and investing via Anchor and Mirror protocol respectively.
On Anchor, with a savings rate of 19.5% on UST, that presents a strong reason to use UST. On Mirror, being able to have exposure to US Stocks and ETF with UST without going through any brokerage and KYC is another strong edge for UST.
So could there be a situation where people lose their conviction that UST will be widely used? Not likely in the current markets but nothing is impossible in crypto. In fact, we’ve seen a glimpse of this during the ‘May day’ crash.
When Luna prices crashed in May, there is panic selling of Luna to UST. This causes more UST to be minted thus increasing UST’s supply causing it to lose its value from 1 USD. When people see their 1 UST is now worth than 1 USD, they swap 1 UST for 1 USD worth of Luna. This continuous high volume of swaps cause the price of UST to fluctuate between 0.9 USD to 1.1 USD.
With how Luna and UST is related, we do see this negative cascading effect when Luna prices tank.
Of course, there is also a counter argument of, as people get through these price crashes, they see that UST is able to maintain its peg thus boosting their confidence in UST such that the next time Luna prices fall sharply, there is less panic selling of Luna and UST.
Next, let’s look at Anchor Protocol.
In what situations will Anchor Protocol fail?
First, we need to ask ourselves how is Anchor able to maintain a 19.5% yield on UST? I’ve covered this briefly here: https://sem1d5.medium.com/heres-how-you-can-earn-20-a-year-on-your-savings-e8458c9c4401
But as a recap, the yield comes from staking rewards from proof-of-stake tokens that are deposited as collateral. Assuming that staking rewards yield 10% annually, for every 1 UST savings, there needs to be 2 UST worth of collateral deposited as collateral in Anchor. This is so that the 2UST worth of collateral can generate 10% yield → about 0.2UST a year. And this should be enough to cover the 19.5% yield for 1 UST.
So a possible scenario where Anchor can fail is, what if there are a lot of deposits (people want to be risk-off and save) and not a lot of people wanting to provide collateral?
Here we see the net amount of bLUNA collateral deposited into Anchor over time. The good news here is that collateral is being added steadily since launch. Even with the May day crash, we do see bLUNA being continuously added into the protocol.
Note that Luna is a volatile asset , if Luna prices drop this would affect the value of the bLUNA collateral too and this too can be a risk.
I have also seen a suggestion to reward people based on the collateral provided instead of UST borrowed. I think that makes sense because in risk-off markets, people would not want to open a collateralized debt position but no harm in depositing collateral without taking out any loans.
Can Mirror Protocol fail?
Apart from smart contract risk and counter-party risk (e.g. oracle failing), there is actually little risk for Mirror protocol.
The only thing I could think of is what if the value of Mir token goes to 0.
Let’s look at the price of Mir from June to August.
Price action does not look too promising currently. The same can be said for the selling volume of Mir to UST.
With this, one needs to ask the question — when incentives become valueless or when incentives for short and long farming ends, will people still use Mirror?
No one knows for sure but I’m actually leaning towards the ‘yes’ camp.
I think there are 2 key reasons for this: Firstly, there are still arbitrage opportunities. People can still short stocks and buy back when markets open and prices are closer to the oracle prices.
The other reason is simply, there will always be an inherent need for people to get exposures to the equities market. Owning an ETF or stock without going through a brokerage? I’d even argue that Mirror is a more ‘fail proof’ driver for the wide use case for UST.
Combating Terra FUD with your new found knowledge
In this article, I’ve walked through how the bull case for Luna and UST could potentially be the same reason why Luna and UST might fail. However, given the vast amount of upcoming projects that will use UST coupled with the two strong core Anchor and Mirror protocols, the demand for UST is high and it’s very unlikely that we see UST de-peg like the tragic case of Iron Finance.
I’ve also shared a scenario where Anchor can fail — where people want to be more risk-off and only provided UST into savings without much demand for providing collateral to borrow UST. Given that we see number of bLUNA increasing even after May day, (a situation where people are more risk averse I’d argue) this just shows that this risk may not be that relevant for the protocol at this point.
Last but not least, the risks for Mirror are very minor. In fact, since there will always be a need to buy equities and commodities, being able to purchase those via Mirror with UST gives UST a strong use case for its widespread adoption.
For more FUD-combating super power with data analytics, check out Flipside!
